Strategy-Driven Supply Chain Fundamentals: Strategy & Benchmarking
Previously, I have shared a detailed look at the supply chain triangle and the ROCE (Return on Capital Employed) metric. These two components are instrumental to explain the importance of supply chain planning for any organization, but our supply chain story is far from over.
In this article, I will focus on the supply chain strategy itself and its impact on the triangle and financial metrics (like EBIT and inventory turns).
Supply chain strategies
How do companies make supply chain choices? That’s the question Treacy and Wiersema answered in 1995 with their book, The Discipline of Market Leaders. In short, we can say that market leaders need to be “extremely disciplined and focused” on one of these three strategic options:
- Operational excellence (best total cost): Focus on operations and efficiency; e.g. Ryanair
- Product leadership (best product): Focus on innovation and marketing; e.g. Apple
- Customer intimacy (best total solution): Focus on sales; e.g. IBM
The same strategies can clearly be found in different sectors, such as airlines, food or fashion, and they will form our framework to discuss how different strategies influence the supply chain triangle and other key financial metrics.
That is why you should start with defining your supply chain triangle (service vs. cost vs. capital employed) and capturing your business problems. This exercise is followed by an (online or offline) questionnaire to understand your strategy.
How do you want to stand out in your market, what is your strategic value proposition and what does your supply chain need to support this strategy?
As a company, you need to make a choice in your positioning. You cannot have three different goals in your market. That would be a too far stretch and you’ll end up with everyone sending conflicting messages, both internally and externally.
Before designing an S&OP process, you need to understand which strategy it needs to support. For instance, if you‘re a customer intimacy player, you will have a broad assortment and focus on service, so you need to develop the right planning processes and tools to support this. Only when the strategy choices are clear, do we move on to discussing possible improvements to the S&OP process.
Different strategies lead to a different supply chain balance
Each strategy requires a different focus in the supply chain triangle. When we take a look at the contrast between a traditional supermarket (e.g. Delhaize) and a hard discounter (e.g. Aldi), we can immediately discern how their strategies affect how they run their organizations.
The strategy of the hard discounter will be centered around operational excellence, offering the best quality at the lowest prices, leading to lower costs and lower capital employed.
On the other hand, the traditional supermarket will primarily aim for customer intimacy, with a larger offer of SKUs, resulting in higher service quality.
Which metrics or financial benchmarking will help you analyze these strategies?
To measure service, for instance, you can look at the gross margin. Typically, product leaders with a unique product or brand can achieve a higher gross margin. Operational excellence players, like Ryanair, work at much lower gross margins. Why? The lowest price is their primary point of differentiation in the market. To measure cost, on the other hand, you can use SG&A (selling, general and administrative expense), excluding the cost of goods, as this is already incorporated in the gross margin.
When we link this strategy exercise back to the ROCE principle, which depicts the margin (service minus costs) over the invested capital, we now see that different strategies are, in fact, different routes to generate Return on Capital Employed.
If you follow the ‘hard discounter route’, you will have lower margins with less SKU complexity and less capital employed. If you choose the ‘traditional supermarket route’, you will have a broader assortment, which leads to more inventory and more capital employed, so you will have to make sure you can drive a premium for that broader assortment and higher service.
Keeping track of your competition with two-dimensional benchmarking
Another way to show the influence of strategy on supply chain metrics is through two-dimensional benchmarking. This type of benchmarking consists of one margin metric on the vertical axis (e.g. EBIT) and a capital employed metric on the horizontal axis (e.g. inventory or cash conversion cycle).
On this scale, you can track your organization’s performance throughout the years. Ideally, you want to be in the top right corner with a very high EBIT and high inventory turns (= low inventory). We can then determine your best performance and establish the ‘best performance line’, which shows all the combinations that lead to the same maximum performance, or ‘bang for the buck’.
Strategy defines where you should be on this curve.
A product leader will be on the top left, with a higher margin, but also a complex product supply chain and the need for a high inventory to compensate for this. At the other end of the spectrum, the operational excellence player can be very efficient, enjoying low supply chain complexity and minimal capital employed. The margins, however, will be equally low, without a lot of product differentiation capabilities.
When you follow this exercise, you can easily benchmark against your own best performance, a particular competitor, the best-in-class for your sector, or a company with the same strategy in another industry (e.g. Ryanair vs. Lidl, both Operational Excellence players).
This type of benchmarking is typically used during the budgeting process or when you are building your business case for an S&OP improvement (mapping realistic targets for a chosen strategy). Afterward, I advise you to incorporate this information in your S&OP process and keep benchmarking your competition to continuously keep track of your own supply chain performance.
A solid base for your strategy-driven supply chain
The supply chain triangle and the ROCE metric can help you convince the executive decision-makers in your company, while the strategic background will offer you a comprehensive framework to back up your supply chain choices and compare them to your competition.
In my next article, I will link all these concepts to the concrete supply chain design and my vision for the future of S&OP and its role in business strategy.